Government Offers Nixonian Rationale for Dismissing Shareholder Rights in Delaware Case

In their latest move to scuttle legal challenges of the Net Worth Sweep, lawyers for the U.S. Treasury Department and the Federal Housing Finance Agency filed briefs this week aimed at preventing the state Supreme Court of Delaware from taking up a shareholder suit focused on the Sweep’s violation of state laws.

The message in the government’s briefs was this: Federal policymakers can interpret the statute any way they want, shareholders should not even be wasting their time pursuing a challenge based on possible violations of state laws, and state courts have no bearing on this matter.

Last summer David Jacobs and Gary Hindes, shareholders in Fannie Mae, sought certification to the Delaware Supreme Court on the legality of Sweep under state law.  The underlying premise in the suit, as with other shareholder litigation, is that the 2012 Sweep of the profits of Fannie and Freddie far exceeds the terms of the Housing and Economic Recovery Act (HERA), but with regard to state laws, the complaint said:

Under Delaware and Virginia corporate law, preferred stock of a corporation cannot be given a cumulative dividend right equal to all the net worth of the corporation in perpetuity. The Net Worth Sweep represents an unlawful confiscation of the entire economic value of the Companies and their other classes and series of stock. The Net Worth Sweep is an illegal term for any preferred stock instrument, whether or not held by the federal government.

In November, the government filed a motion to dismiss the case, making broad assertions about sovereign immunity, federal power over the states, and the wide latitude HERA provides FHFA. Briefs filed this week in U.S. District Court in Delaware seek to thwart the case from advancing and detail the government’s rationale for these assertions.

Hindes and Jacobs acknowledged that Fannie and Freddie are chartered under federal law. However, they argue that state bylaws apply to the GSEs’ corporate governance practices and procedures – specifically strict limits of the power of any corporation to issue preferred stock.  Fannie Mae follows Delaware law and Freddie Mac falls under Virginia’s jurisdiction. No less an authority than former Delaware Supreme Court Chief Justice Myron Steele is helping them make their case. He has warned that the federal government is setting a dangerous precedent for any publicly traded corporation in any state. In a brief, Steele wrote:

Were the Net Worth Sweep to be upheld as permissible under Delaware and Virginia law, a very troubling precedent would be set for those states’ corporate laws, for stockholders of corporations of those states, and for the mergers and acquisitions community as a whole, because such precedent would appear to extend equally to corporations not under conservatorship and without the federal government as their senior preferred stockholder, and thereby permit the directors of a Delaware or Virginia corporation unilaterally to contract away all of the net worth and profits of the corporation for all time to a single preferred stockholder.

This week, government lawyers essentially reiterated that the terms of the conservatorship under the HERA, as well as the Sweep of Fannie and Freddie’s profits, are related to a federal statute. Period. The Treasury brief essentially said HERA negated shareholders’ rights.

FHFA’s brief asserted its broad powers as conservator under HERA to justify the Sweep. Remarkably, FHFA and Treasury have consistently omitted mention of the part of HERA that requires FHFA to “preserve and conserve” the assets of Fannie and Freddie.  The siphoning of funds from privately-held companies, even companies with government charters, is not allowed in corporate law. Somehow, government lawyers would have the court believe that it is acceptable when the looting is done by the government. This conjures up Richard Nixon’s contortion about his culpability in the Watergate scandal in an interview with David Frost: “When the president does it, it is not illegal.”

In the next two weeks, the judge in the case will either dismiss the suit, which could prompt an appeal by plaintiffs. Alternatively, the judge could let the case proceed to the Delaware State Supreme Court or simply issue a ruling.

Whatever happens, there will be more opportunities for plaintiffs to demonstrate that the government is making the audacious claim that it can enter into agreements with itself to suspend laws at its discretion.  Each step in the process will reveal the hollowness of the government’s claim that it has acted as the savior of the Fannie Mae and Freddie Mac. In fact, Treasury has looted the companies in an arbitrary and capricious conservatorship that has gone on for too long.  The sooner this arrangement ends, the better.